Corporations as Beneficiaries

It is often quite useful to have Holdco own shares of Opco through a trust rather than directly. In general, the other beneficiaries of the trust can still claim the capital gain exemption in respect of a disposition of the shares of Opco, and keeping the redundant assets of Opco to a minimum while deferring tax at the individual shareholder level can be as simple as paying a dividend from Opco that is allocated to Holdco as a beneficiary of the trust.Of course, making a corporation a beneficiary of a trust has its own set of issues, and some of the most important aren’t tax related. I’ll leave the non-tax issues to a non-tax expert, however. In this post, I want to focus on the technical tax issues.

Perhaps the most important tax issue for a corporate beneficiary is Part IV tax. If Holdco is subject to Part IV tax on dividends it receives from Opco because the former is a beneficiary of a trust, then not much has been accomplished from a tax perspective. No deferral is available because of the imposition of the refundable tax, and the individuals involved would have been better off simply paying dividends to themselves to effect creditor-proofing and reduce excess redundant assets.

To avoid Part IV tax, Holdco must be connected with Opco, and Holdco will be connected only if it satisfies either the 10% votes and value test or it controls Opco.

To satisfy the 10% votes and value test, Holdco must own shares of Opco. The CRA, however, takes the position that the beneficiary of a trust does not own the trust’s property. Holdco, then, if it “holds” shares of Opco only as a beneficiary of a trust, can never satisfy the 10% votes and value test. For example, assume that Steve is the owner of all of the shares of Holdco, which is the beneficiary of a trust that owns 30% of the issued shares of Opco. The remaining 70% of the shares of Opco are held by an individual with whom Steve deals at arm’s length. In these circumstances, Holdco will not be connected with Opco because it does not own any Opco shares.

Holdco will be connected with Opco only if Holdco controls Opco under subsection 186(2) of the Income Tax Act (Canada) (the “Act”). Holdco will control Opco only if persons not dealing at arm’s length with Holdco own more than 50% of the shares of Opco having full voting rights in all circumstances.

Holdco is deemed not to deal at arm’s length with the trust of which it is a beneficiary as per paragraph 251(1)(b) of the Act. Subsection 186(2) states that, for the purposes of its definition of control, Holdco will be deemed to own all of the shares held by a person with whom Holdco does not deal at arm’s length. Of course, in our example above, Holdco will be deemed to own only 30% of the issued shares of Opco, which is unhelpful from the standpoint of Part IV tax. The position would be different if the trust held 70% of the issued shares of Opco. In that case, Holdco would be deemed to own the shares, and so it would be deemed to control Opco. Holdco would be connected with Opco, and the CRA accepts that any dividends paid by Opco to the trust that are then allocated to Holdco would be free of Part IV tax (assuming that Opco did not receive a refund of tax in respect of the dividends declared).

What happens if two brothers, A and B, each own all of the shares of their respecting holding corporations (HoldcoA and HoldcoB), which in turn are beneficiaries of trusts (TrustA and TrustB) that own 50% each of Opco? Neither TrustA nor TrustB controls Opco by itself for the purposes of Part IV: neither owns more than 50% of the voting shares of Opco. The Holdcos, however, will be related to each other (per paragraph 251(6)(a), subparagraph 251(2)(c)(ii) and paragraph 251(1)(a) of the Act). In addition, paragraph 251(1)(b) of the Act provides that

a taxpayer and a personal trust (other than a trust described in any of paragraphs (a) to (e.1) of the definition “trust” in subsection 108(1)) are deemed not to deal with each other at arm’s length if the taxpayer, or any person not dealing at arm’s length with the taxpayer, would be beneficially interested in the trust. [Emphasis added]

In the example above, HoldcoA and HoldcoB are deemed not to deal at arm length with each other. As a result, HoldcoA is deemed not to deal at arm’s length with TrustA and TrustB. HoldcoA is deemed not to deal at arm’s length with TrustB because HoldcoA and HoldcoB are related and HoldcoB is beneficially interested TrustB. HoldcoA, then, is deemed to control Opco under 186(2), and any dividends paid from Opco through TrustA to HoldcoA should not be subject to Part IV tax (assuming that Opco doesn’t have RDTOH).